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Monday, November 10, 2008

Latvian Inflation Falls Back Again In October

Latvia's October inflation rate decreased to an annual rate of 13.8 percent, the fifth straight month the indicator has fallen as the economic contraction which has followed the boom bust cycle starts to get a grip. Month on month prices were still up by 1.2% over September. That is they were still growing at a 7.2% annual rate. Thus, despite the drop, Latvia continues to have far too much inflation, and still has the highest inflation in the 27-member European Union. In 2006 the economy expanded 12.2 percent, in Q3 2008 it contracted by 4.2% over Q3 2007.

While the slowing pace of consumer-price growth will be welcome news to Latvians, we need now to look out carefully for a new menace: deflation. From now on we will be looking at the evolution in the index itself as well as the year on year changes, to see if we can spot just exactly when the economy falls over into deflation mode, and see if we can judge just how fast prices will fall - and the economy contract as a consequence. At the present time however there seems to be little danger of deflation, as the consumer price index goes hurtling onwards and upwards.

The Central Bank Buys More Lati

The Latvian central bank bought LVL 16.3 million in the domestic foreign exchange market last week to support the Lat after it weakened to the limit of its trading band, according to data from the central bank. The lats fell to 0.7098 against the euro for the fifth consecutive week, prompting the bank to buy in defence of the band. In principle the currency is allowed to rise or fall 1 percent from a midpoint to the euro. The central bank has now bought LVL 293.3 million over the last six weeks. At this point the peg is not under any great threat, since Latvia had foreign currency reserves of about USD 5.4 billion at the end of October, or a little over four months of imports. Four months imports is normally considered the minimum however to protect a currency from attack, so they do need to watch out. The most likely situation is that the bank and the government are already, as I reported on this blog some weeks ago, in day to day contact with the IMF.

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